The Bank of Canada, Rate Cuts, and Adjustable Mortgages

The Bank of Canada has decreased its overnight lending rate by 25 basis points. This is the first decrease we’ve seen since March. It seems that since COVID, everyone has become an expert on the Bank of Canada, but let’s step back and clarify what’s really happening.

The Bank of Canada’s primary responsibility is to keep inflation low, stable, and predictable. Its official target is 2%.

To guide decisions, the Bank measures key data such as the Consumer Price Index (CPI), which tracks the cost of goods and services Canadians buy every day. It also looks at employment numbers, wage growth, housing activity, and overall gross domestic product (GDP). These indicators give a picture of whether demand in the economy is outpacing supply and putting upward pressure on prices.

The primary tool the Bank of Canada uses is the overnight lending rate, the interest rate that the major financial institutions borrow and lend one-day funds among themselves.

That rate is now 2.50%. Now that you’ve had your quick Bank of Canada crash course, let’s carry on to the parts that actually hit your wallet.

Here’s the part that often causes confusion: the overnight rate is not the rate that Canadians borrow.

Lenders set the prime rate; currently the prime rate is 4.70%.

If you’re thinking, “Shouldn’t that be 2.5% + 2% = 4.5%?”

You’re right to ask. 

The answer lies in history.

A history lesson: In 2015, the Bank of Canada made two cuts of 25 basis points. On January 20 and July 14. Instead of passing along the full cut, major banks only reduced prime by 15 basis points. They didn’t match the Bank of Canada. As a result, Prime (the rate you and I use) has been set at about 2.2 percent above the Bank of Canada’s rate, rather than the 2% spread.

This shows that while the Bank of Canada leads, the banks don’t always follow.

• A Bank of Canada cut doesn’t guarantee fixed mortgage rates will drop. Fixed rates move with the bond market, mainly Canada’s five-year bond yield and the U.S. 10-year bond.

• A Bank of Canada cut affects adjustable-rate products immediately, like adjustable-rate mortgages, lines of credit, and some variable-rate credit cards.

Understanding the difference between adjustable and variable mortgages is important.

Adjustable means your payment moves with the rate.

Variable means your payment stays the same, but the interest and amortization in the background shift.

When rates rose after COVID, clients with adjustable mortgages saw their payments increase, while those with variable mortgages saw their amortization stretch.

Looking ahead, we may see another cut closer to Christmas, but if inflation ticks back up, the Bank of Canada could raise rates again. Their priority is always keeping inflation near 2 percent.

The takeaway:

1. The Bank of Canada moves the overnight rate, but banks don’t always pass along the full change.

2. Fixed mortgage rates follow bonds, not the Bank of Canada directly.

3. Adjustable-rate borrowers feel the effects almost immediately.

If you have questions, call me.